Why Can Margin Requirements Increase Volatility and Benefit Margin Constrained Investors?
Review of Finance (2016) 20 (4): 1449-1485
56 Pages Posted: 9 Feb 2012 Last revised: 30 Aug 2017
Date Written: July 13, 2015
Abstract
We propose a tractable equilibrium model to examine how margin requirements affect asset prices, market volatility, and market participants' welfare. We show that margin requirements can have opposite effects on market volatility when they constrain different investors and thus can help explain why empirical results have been mixed. Contrary to one of the main regulatory goals, we find that even though margin requirements restrict borrowing and shorting, they can significantly increase market volatility. In addition, margin requirements can make margin constrained investors better off and can lead to a greater return reversal. Our analysis also provides new empirically testable implications.
Keywords: Margin Requirements, Short-sale Constraints, Volatility, Liquidity, Welfare
JEL Classification: D53, D61, D82, G12, G18
Suggested Citation: Suggested Citation
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